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14.10.13

Outsourcing: the new Fair Deal on pensions

Source: Public Sector Executive Sept/Oct 2013

Martin Potter, partner at pensions consultancy Hymans Robertson, says that a shake-up to public sector pensions could see 500,000 contractors move back into unfunded government-backed pension schemes in a bid to inject competition into the public sector outsourcing market.

Pension requirements for more than 500,000 employees of public sector contractors are changing.

The Government’s ‘new Fair Deal’ policy will mean that companies working in the public sector (including within the NHS, teaching and central government staff) will soon be able to let new staff stay in public sector pension schemes in respect of new contracts rather than being required to offer them access to their own schemes. They will also be able to transfer existing staff back into public sector pension schemes at the end of existing public sector contracts.

This could be good news all round, although the devil of course is very much in the detail. The defined benefit pensions that contractors are currently required to provide to transferred staff are expensive, carry significant financial risks and complexity, and act as a deterrent to many organisations (including SMEs and charities) from tendering for outsourcing contracts. By enabling contractors to participate in public sector schemes some of these pensions obstacles are removed. This would smooth the way for new contractors to enter the market and hopefully increasing competition, reducing costs and increasing innovation for public services. It also makes pension provision simpler for members and contractors to understand.

Significant time is currently spent addressing pensions in the tendering stage of a contract. If contractors could instead enter into a standard participation agreement in the relevant public sector scheme for all new contracts, time and effort will be saved for all parties. This will level the playing field for bidders and the standardisation will make life fairer and easier for awarding bodies.

The pension contribution rate is expected to be set at the same level for all participating employers, so the pension cost is arguably removed from the equation when reviewing bid prices. This helps the awarding body to judge each bid on the bidder’s ability to provide the service rather than their pension management expertise, which is surely fairer to all.

It is proposed that ‘risky’ employers may be levied with an additional 2% of payroll to protect the public sector. Contractors are understandably cautious about how their ‘riskiness’ is measured and its wider implications for their business. More clarity will be required here and a balance needs to be struck so that protecting the awarder doesn’t deter new contractors who fear they may be unfairly deemed risky (and whose bid would be rendered less competitive at a stroke).

Financial risks for contractors will no longer be open-ended in a public sector scheme. Nevertheless, the public sector scheme does need to be protected. At the end of the contract the contractor is likely to be on the hook for additional costs arising from actions within their control to protect the public sector scheme (for example, if they grant excessive pay increases that feed into members’ pension amounts or they default on payments during the contract term). Whilst this sounds a reasonable approach to take, contractors need to be sure of the detail of such penalties before signing on the dotted line.

In a similar vein, contractors may be required to arrange bonds, guarantees or insurance against not being able to pay their contributions – the cost of these may be prohibitive so contractors may seek flexibility here. Whilst new contracts and those covered by old Fair Deal will be subject to new Fair Deal in future there is no mention of the requirements for contracts outsourced prior to old Fair Deal. It is not clear whether these staff will be eligible to return to the public sector scheme on a contract renewal. The distinction could be removed, provided the terms do not unduly expose the public purse.

The Treasury has indicated that employees on new contracts (and old Fair Deal contracts) will be eligible to remain a member of the public sector scheme whilst they remain working wholly or mainly (in central government contracts, deemed to be 50% of the time) on the contract. However, many contractors will expect to derive efficiency from employing some staff more widely. A pragmatic approach is needed to balance flexibility with subsidy of generous pensions for staff working away from the public sector.

These changes are likely to have a real impact on the public sector, injecting a shot of competition into the outsourcing market by opening up the barriers to SMEs, charities and others that might have previously been out of contention.

It may also prompt outsourcers into other public services where this option has been uneconomical in the past. Whilst these changes are broadly positive for the efficiency drive however, some points will need to be cleared up before they take effect.

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